Letter Were James M

New York State Bar Association NYSBA One Elk Street, Albany, New York 12207 • 518/463-3200 • http://www.nysba.org TAX SECTION MEMBERS-AT-LARGE OF EXECUTIVE COMMITTEE . William G. Cavanagh Jeffrey D. Hochberg Janet B. Korins Matthew A. Rosen Gordon Warnke 2004-2005 Executive Committee Edward E. Gonzalez SherwinKamin Sherry S.Kraus SethL. Rosen David E. Watts LEWIS R. STEINBERG Alysse Grossman Arnold Y. Kapiloff Jiyeon Lee-Lim Joel Scharfstein Paul R. Wysocki Chair David R. Hardy Charles I. Kingson Deborah L. Paul Bryan C. Skarlatos Cravath, Swaine & Moore LLP Worldwide Plaza 825 8* Avenue New York, NY 10019 212/474-1656 DAVID P. HARITON First Vice-Chair 212/558-4248 KIMBERLYS.BLANCHARD Second Vice-Chair 212/310-8799 August 24, 2004 PATRICK C. GALLAGHER Secretary 212/446-4998 The Honorable Members of the Finance Committee of the U.S. Senate COMMITTEE CHAIRS: Bankruptcy and Operating Losses The Honorable Members of the Committee on Ways and Means of the Lawrence M. Garrett Stuart J. Goldring U.S. House of Representatives Compliance, Practice & Procedure Barbara!. Kaplan The Honorable John W. Snow Ellis W.Reemer Consolidated Returns Jonathan Kushner Linda Z.Swartz Subject: Senate JOBS Bill Amendments to Section 269 Corporations Kathleen L. Ferrell Jodi J. Schwartz Employee Benefits Ladies and Gentlemen: Karen G. Krueger Max J. Schwartz Estates and Trusts T. Randolph Harris I am writing on behalf of the Tax Section of the New York State JetfreyN. Schwartz Financial Instruments Bar Association concerning section 435 of H.R. 4520, the Jumpstart Our Michael S. Farber ErikaW.Nijenhuis Business Strength (JOBS) Act as passed by the Senate on July 15, 2004 Financial Intermediaries David M. Schizer ("JOBS Bill"). Section 435 of the JOBS Bill would expand the reach of Andrew P. Solomon Foreign Activities of U.S. section 269 of the Code. There is no comparable provision in the version Taxpayers Peter H. Blessing of H.R. 4520 passed by the House on June 17. David R. Sicular Multistate Tax Issues Robert E. Brown Section 269 grants the IRS discretion to disallow tax benefits in Paul R. Comeau New York City Taxes certain corporate transactions the principal purpose of which is evasion or Robert J. Levinsohn Irwin M. Slomka avoidance of federal income tax by securing a tax benefit that would not New York State Franchise and Income Taxes otherwise be enjoyed. The amendments would extend the disallowance Maria T. Jones Arthur R.Rosen rule to reorganizations and liquidations that take place between members Partnerships William B. Brannan of a corporate group. They would also prevent a taxpayer from defending David H. Schnabel Pass-Through Entities against an IRS attack on the use of tax benefits in a transaction by showing Gary B. Mandel Andrew W. Needham that those benefits could have been enjoyed through other means (the Real Property David E.Kahen "other means exception"), as discussed below. The changes would apply Elliot Pisem Reorganizations to stock and property acquired after February 13, 2003. Karen Gilbreath Diana L. Wollman Securmzations and Structured Finance 1 David S. Miller The principal drafters of this letter were James M. Peaslee and Yaron Z. Reich. Charles M. Morgan, III Comments were received from Kim Blanchard, Peter Blessing, Samuel Dimon, Tax Accounting David W. Mayo Kathleen Ferrell, Patrick Gallagher, Edward Gonzales, David Hariton, Richard Marc L Silberberg Loengard, Deborah Paul, and Michael Schler. Tax Exempt Bonds O ' " Margaret C. Henry Stuart L Rosow Tax Exempt Entities Dickson G. Brown Michelle P. Scott U.S. Activities of Foreign FORMER CHAIRS OF SECTION: Taxpayers Samuel Brodsky Alfred D. Youngwood Richard G. Cohen Peter C. Canellos Robert H. Scarborough Yaron 2. Reich Edwin M.Jones Gordon D. Henderson Donald Schapiro Michael L. Schler Robert A. Jacobs Andrew Walker Peter Miller David Sachs Herbert L. Camp Carolyn Joy Lee Samuel J. Dimon JohnE.Morrissey.Jr. J. Roger Mentz William L Burke Richard L. Reinhold Andrew N.Berg Martin D. Ginsburg Willard B. Taylor Arthur A. Feder Richard 0. Loengard Peter LFaber Richard J. Hiegel James M. Peaslee Steven C. Todrys Hon.RenatoBeghe Dale S. Collinson JohnA.Corry Harold R. Handler Do the Public Good • Volunteer for Pro Bono The proposed amendments to section 269 stern from the Joint Committee on Taxation staffs February 2003 report discussing various tax-motivated transactions entered into by Enron Corporation ("Enron Report").2 A common feature of these transactions is that they were not incidental to normal commercial transactions and involved tax benefits attributable to carryovers of built-in loss assets and loss duplication. Joint Committee on Taxation, Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations (JCS-3-03), February 2003. The main transaction that gave rise to the section 269 proposal was Project Cochise. It involved a transfer in a section 351 transaction of high-basis, low- value REMIC residual interests from Bankers Trust to a corporate subsidiary of Enron named Maliseet. Those assets were expected to produce phantom income in early years followed by losses in the later years. Maliseet also acquired income-producing assets. Maliseet elected REIT status so that it was not part of the Enron consolidated group. Its phantom income was allocated to Bankers Trust through consent dividends paid on the stock held by Bankers Trust. At a later point, the entity was expected to be recapitalized and brought into the Enron consolidated group so that Enron could benefit from losses from the residual interests. The main purpose of the transaction was to allow Enron to book financial statement earnings attributable to the anticipated future tax benefits. The transaction also allowed a duplication of losses in that the basis of Bankers Trust in the Maliseet stock it received in exchange for the residual interests reflected the high basis in those assets. The tax opinion relating to the transaction assumed that the transfer of REMIC residual interests to Maliseet was subject to section 269(a)(2) (dealing with carryover basis transfers of assets to a corporation where the transferee does not control the transferor) but argued that the principal purpose of the transfer was not tax avoidance. (Section 269(a)(l) did not apply because Maliseet was a pre- existing subsidiary.) This conclusion was based primarily on the fact that future phantom losses of Maliseet would be attributable more to the post-acquisition income derived from the residual interests than from the pre-acquisition income (and the resulting basis). The benefits from post-acquisition income would have been realized even if Maliseet had purchased the residual interests in a fully taxable transaction. The opinion also notes that the profits to be derived from contributed assets plus the financial accounting benefits were substantial non- tax benefits and may have outweighed the tax benefits. (cont'd) Recommendations We strongly support the Senate's objectives in preventing tax- motivated transactions of the type discussed in the Enron Report. However, we are concerned that, if enacted in their present form, the amendments would do more harm than good because they would subject new categories of transactions to a tax avoidance test without providing adequate standards for distinguishing illicit tax avoidance from permitted tax planning. Also, elimination of the other means exception could produce improper results in cases in which section 269 already applies. Accordingly, if Congress decides to proceed with the section 269 changes, we recommend that the amended section not be effective until implemented through regulations, with an exception for clear abuse cases. Treasury and the IRS could then define more clearly through regulations which categories of transactions involve tax avoidance of the prohibited type and which do not. The regulations would be open to comment and review before adoption. Presumably, the regulations would include not only standards but also a number of examples. Abusive transactions that would be affected by amended section 269 with a current effective date should be defined by reference to the Enron Report as transactions that are not incidental to normal commercial transactions and involve tax benefits attributable to carryovers of built-in loss assets and loss duplication. If the effective date is not delayed until implementing regulations are issued, then, at the least, we believe that the conference report should provide additional guidance on the intended scope of the statute. It would be helpful to state, for example, that the changes are aimed at tax avoidance transactions of the Enron variety that are not undertaken as (... cont'd) Interestingly, it is not entirely clear whether the proposed amendments would have thwarted the Cochise transaction since the tax opinion in that transaction essentially concluded that the principal purpose of the transfer was not tax avoidance, and it is arguable to what extent that conclusion was based on the other means exception. incidents of regular commercial activity and are not regarded as routine tax planning under current standards. In addition, we recommend that Congress explain the reasons for eliminating the other means exception. For example, we believe that it would be very helpful if the conference report were to include examples like those given in this letter and state that they do not involve tax avoidance of the type Congress has in mind. While

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